How to track down the strongest company moats this ISA season

With the end of the tax year around the corner, the eyes of the UK investment industry are all on ISA season. It’s the time when the tax-free savings allowance for the current year expires, and next-year’s allowance kicks off.

For some investors it will be imperative to get funds invested quickly. But for others there will be no rush. Last year, ISA season coincided with benign market conditions that were kind to equities. But this year it comes after a modest pull back in index prices. For some, that’s heightened a sense of uncertainty about the direction markets will go in this year.

One of the themes that I’ve previously covered at ISA season is the idea of economic moats. Companies with durable moat-like features tend to be sought after. With strong competitive advantages, the idea is that they can compound returns fairly reliably over many years. But while moats are quite easy to define, it’s not quite so easy to be definitive about which companies actually have them.

What makes a moat?

It’s Warren Buffett who takes credit for the concept of moats. He often mentions the idea of finding and holding good quality firms that generate high returns on capital and are well-protected from competition.

“The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.”

Low cost and powerful brands (or patents) are two characteristics of firms with defendable businesses, but there are others.

Sheer scale in areas like manufacturing and distribution can be very hard for other companies to compete with. Switching costs are another major factor. When customers are turned off by the hassle of changing from one product or service to another, then that can be a sign of a strong moat. Likewise, some services have a network effect, where they become more valuable as more and more people use them, which again can be a powerful moat.

In his book, The Little Book that Builds Wealth, Pat Dorsey, a fund manager and former Morningstar…

Unlock this article instantly by logging into your account

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.

Ben, Great article as ever. Coincidentally I was looking at some Moat companies this morning. I have noticed that MOAT companies tend to have high QM scores , so if I plot your FT350 Moat Screen as a bubble chart and select the Quality vs. Momentum tab, we see the majority of these Moat companies in the, “Good stocks that tend to outperform” segment.

FTSE 350 Moat Screen - Quality vs Momentum

But Aim 100 has some great Moat companies too. To illustrate this if we plot all the AIM 100 companies as the same Quality vs. Momentum bubble chart also see clustering to the top right in the, “Good stocks that tend the outperform” segment.

What is more remarkable is that the AIM 100 bubble group have been selected by their £market cap only, with no additional screening for bumper 5Y returns, or high Stockranks. This maybe why AIM 100 as a group has done so well in the last year, or so. Ian

P.S. If you added a QM >80 score to the FTSE 350 Moat screen, unloved Moneysupermarket (which has a QM of 62) would disappear!

Great article Ben but the FTSE 350 based screen. .I would love to see the same screen applied to the US sector .After all the FTSE is really gowing nowhere especially with the brixit uncertainty .The US and europe /Asia is where the growth is. The FTSE is only 20 % of the world stockmarket and we need to broaden our investment horizon..

Thanks Ben...that was something I hadn't thought of: the persistence of quality scores versus value scores. A pure value approach means that you have to keep finding new stocks, as cheap stocks in your portfolio mean reverts to a more normal (more expensive) valuation. Whereas quality ought to last longer - so interesting that stocks with high quality scores seem to appear year after year.

I have 2 Buffetology type quality screens, one using 1Y returns and one using similar selection criteria, but with the key return metrics as 5Y averages. The companies they select are almost identical for 1Y and 5Y average, i.e. Historically very high quality companies "typically" persist for 5 years.

This discovery has moved my investing style toward more high PE Moat type companies that I expect to hold for the long term. My very best investments have used this style and it suits my particular personality. Ian

It seems to be a great idea. Recently I received an email containing details of the author's latest way to make excellent returns long term. The only reason I took notice was that I have read his book and he was instrumental in setting up MSMoney' screening system. Basically it's based on research by a university's findings that of the American stock market about 30 stocks make the long term big money.
Wonder what it would show if applied to the UK market.

Strategies Editor at Stockopedia. My goal is to help private investors learn and invest with confidence through the articles, ebooks and other resources we publish on site. I also occasionally bunk off to interview famous investors at expensive restaurants. I studied History at Aberystwyth University, trained as a journalist and covered business news and corporate finance before settling in as one of the first staff members at Stockopedia. Away from Stockopedia I'm a mountain bike junkie. more »